The private employer-sponsored defined benefit plan has had a good run of it, supporting two generations well in its goal of providing economic security  for retirees.  But the last 10 years have seen gradual though substantial decline in the number of employers sponsoring these plans, and in the percentage of employees being covered by these plans-now somewhere well south of 19% of the workforce is covered.The economic collapse has exacerbated the problem even further by exposing the weaknesses of the system, as the remaining DB plans are seeking funding relief from Congress.

You can find many sound opinions which attempt to explain this demise, from over-regulation, to difficult statutory schemes,  to the allure of defined contribution plans. If you step back, though, you can see that all of the reasons for the demise have a central theme: private employers are structurally ill-suited to bear the lifetime risk associated with providing this kind of benefit.

Think about it. Private business can, and indeed some must, fail. These companies  grow, expand and, ultimately either fail or need to be exposed to the risk of failure. There is a lot of conversation at the policy level about the evils inherent in having companies that are "too big to fail."  So what is the sense, then, to rely upon companies that we structurally need to fail from time to time to be responsible for funding a lifetime risk of their employees? One may claim that this is the function of the PBGC, but the PBGC doesn’t specifically reserve for risks undertaken by plans. Its reserving system is ad hoc, at best.

Taking a close look at the current DB funding rules, you can see that they really require employers to have, or buy, sophisticated actuarial and investment expertise that you will only normally find in a regulated financial institution. We are, in effect, demanding our manufacturing base to become experts at insurance.

These employers are also seeing the changing nature of their workforce and retiree population, and they find that the DB Plan is unable to meet employee and retiree demands. DB Plans are, for the most part, proverbial “one trick ponies,” whose inflexibility has limited their usefulness in the current marketplace.

I have blogged on popular new annuity products in the marketplace, many of which are reliant upon sophisticated hedging strategies.  These innovative annuity products include features well beyond anything that could be offered in a traditional DB plan. These includes features like (but not limited to) the elective, periodic purchase of a pension guarantee with each payroll; the ability to access cash balances with minimum penalties; equity participation which will raise or lower the lifetime income guarantees; guaranteed minimum withdrawal benefits; guaranteed minimum income benefits with equity participation; and variable annuitization.  Employers who sponsor DB Plans are not in the business of developing and providing these sophisticated guarantees to meet changing employee and market needs. Additionally, plan sponsors generally have limited skills in even maintaining traditional DB benefits, much less having the resources to provide a wide variety of lifetime payout benefits which can adapt to change. They are also severely restricted by a regulatory scheme which discourages innovation. 

What is the answer? Most will agree that the former insurance schemes are sorely inadequate: inflexibility in pricing, little transparency, little portability, and irresponsible acting in some quarters has fueled the current economic mess. What the insurance industry DOES have is the necessary skills and regulatory scheme to guarantee and manage the solvency risks inherent  in guaranteeing life time income.  

Mark Iwry and Phylis Borzi both have recently noted noted their commitment (and cooperation) to providing a sensible regulatory scheme for providing annuitization from defined contribution plans, which will rely upon transparency, simplicity, relevancy and portability. To make this really work, we will need legislative relief as well, in such things as providing a "double 415" limit in such plans in order to provide the same sort of tax benefit which is available for sponsors of DB plans.

Should the insurance industry be able to answer this call, we may be able to finally have a sensible approach to providing retirement income from employer sponsored retirement plans.

 

For further discussion on this matter, see this link. 

 

 

Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

 

 

 

 

 

There are still a number of critical tax issues related to the 2007 403(b) regulations that need to be resolved.  For example, the IRS needs to clean up the horrible mess created by the ambiguities of Revenue Procedure 2007-71, and it needs to come to terms with the fact that mutual fund custodial accounts should be able to be distributed upon plan termination. For the most part, however, answers to the remaining tax  issues are  being wrought through a transition processs -albeit sometimes painfully.

What is really turning out to be the gravaman of the 403(b) marketplace, the one laden with the most liability for plan sponsors and the one with the most intractable problems are those related to the application of ERISA Title I.

For many years, a large number of 403(b) plans assumed that they fell well within the ERISA safe harbor,  which permits such plans to operate without regard to ERISA.  Others, because of the individual nature of the annuity selections, never considered that they were covered by Tile I, but would have realized that they have always been covered if they took a serious look.

The new regs have complicated the ERISA matters by forcing more accountability upon 403b plan sponsors, which has resulted in some serious catfights between employers and vendors about who has responsibility for what. This has ultimately resulted in a large number of even safe harbor plans finding themselves in the throes of Title 1.

Title 1 ‘s most obvious problem is the 5500, because, concurrent with the rest of this mess, is the new requirement that 403(b) plans are now subject to the full 5500 rules which have always covered 401(a) plans.

But the story does not end with 5500. Here are some thoughts (by no means exhaustive, by the way) of the true difficulty of what a non-ERISA plan has to go through when it bites the bullet and accepts  ERISA responsibilities:

-Corporate Action. Recognize, by formal corporate action, the “establishment of a plan” under ERISA Title 1.

–Vendor cooperation.  The vendor needs to transition its relationship with its vendors, and resolve compliance responsibilities

–Spousal consent/beneficiary designations. Perhaps the most significant issue, is working through and now applying these rules properly.

–ERISA-ify the Document and Summary Plan Description.

–Investment classes. Many investment classes under non-ERISA custodial accounts aren’t available under ERISA.

–ERISA Compliance Co-ordination.

–Establishing Plan Governance Structure including:

–ERISA Committee

-Claims and Appeals process.

–Investment Policy, geared toward the unique aspects of 403(b).

–Insurance.  ERISA bondng and fiduciary insurance.

–Audit and Annual Report.

-Participant Notifications, statements and disclosures.

Its going to be a difficult and time consuming process.

Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

 

 

We have posted a number of blogs and otherwise written over the past year discussing the growing role of the SEC in the retirement plan market. See, especially, the article on the SEC’ sand DOL’s "Cross Agency Waltz." The ERISA sessions at the National Society of Compliance Professionals, at which I spoke, were particularly well attended.

The fact that the DOL and the SEC held their first ever joint hearings in June, reviewing target date funds, is further evidence of the SEC’s continued interest in a field which has been traditionally dominated by the Treasury and Department of Labor.

The SEC’s rules have always had particular applicability to the 403(b) marketplace. But the SEC also has leverage into the 401(k) market, a market which often pays scant attention to the agency. in addition to the SEC’s  authority to regulate registered investment products,  a participant’s interest in a 401(k) plan is still, legally, a "security" under its jurisdiction. 401(k) plan interests  may be exempted from the registration and filing requirements of the ’33 and ’34 Acts, but they ARE NOT exempted from those laws’ anti-fraud provisions. So, the agency has every right to investigate fraudulent activities related to the provision of 401(k) plans to plan participants. This is particularly why last year’s  Memorandum of Understanding between the SEC and the DOL-promising cooperation at the investigation and enforcement level- becomes so critically important to retirement plan consultants and practitioners. It will be interesting to see what level of SEC/DOL cooperation we see coming out of the DOL’s Consultant and Adviser Program, which is investigating abusive practices of pension advisers.

This is all reinforced by an October 22, 2009 speech to the AARP by Mary Schapiro (Chair of the SEC), reported in BNA Pension and Benefits Daily. Here is an excerpt from that speech which really puts the retirement plan community on notice:

 

"In my view, financial service firms should engage in responsible product development in the retirement market. Barraging investors with retirement products that feature the latest financial gimmick or marketable fad will not ultimately serve investors’ interests.

America’s future retirees deserve products that they can understand and evaluate. This means that complex fee arrangements or product descriptions should be discarded in favor of simple, clear disclosure.

Our future retirees should have access to products that will help them meet their retirement goals without imposing inappropriate risks. Products offering enhanced leverage and avant-garde investment techniques may be appealing to those investors that want to speculate. But they are not the type of investment products that belong in the retirement portfolio of the average American seeking to provide for security in retirement.

In addition, extolling the eye-popping results of the short-term performance of certain investment products, without focusing on the long-term implications or risks, can result in disappointed investors and potentially angry plaintiffs — not to mention an SEC prepared to be aggressive in enforcing the investor protection rules.

These types of disclosure, product development and marketing issues surrounding retirement products will be areas of focus in the coming year for those of us at the SEC. The burden imposed on those investing for retirement is significant, especially after the market events of last year and we must be committed to assisting those investing for retirement."

 

 

 If you didn’t believe it before, you probably really need to take notice now. The SEC is very interested in your world.

 

Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

 

A couple of months ago, I began writing about the fiduciary concerns related to the purchase of annuities as distributions from  individual account DC plans. In that Part 1, I noted that there are five elements, so called "I’s", which need to be addressed by any plan annuity. In that blog I focused on  "irrevocably", the fiduciary risk of what I called the "30 year risk"-on how one gets comfortable with the inherent risk of an insurance company failing over an annuitant’s lifetime.

Inflexibility and Inaccessibility

 These two "I’s" are closely related, as they really point out the nature of annuity products which are purchased for annuitztion from DC plans: they are plan investments. Treating them otherwise risks turning the DC plan into a DB plan, the ultimate disaster for this kind of program. So the fiduciary focus should be on how to address these elements in choosing annuities as investments under the plan.

Lets talk about what the fiduciaries need to deal with, and about what I mean when I say say irrevocable and inflexible. Traditional annuities are inflexible. Period. You get the monthly benefit you pay for. They provide a very valuable benefit which should be part of anyone’s retirement planning, but this inflexibility can be scary, as it takes away from the participant the ability to address unexpected contingencies. This fear comes from the second point: the funds used to buy the traditional annuity are gone for good. Other than payments made under a survivor annuity, the traditional annuity doesn’t give the participant any access to funds to pay for contingencies, nor does it typically pay a death benefit. So what’s a fiduciary to do?

It’s a plan investment. Unlike a DB plan, Including the annuity in a DC plan is a fiduciary decision-not a settlor function. So plug something like this into the normal fiduciary process:

  1.  Decide whether you really want this sort of traditional annuity within the plan, and whether you want to limit the purchase to a portion of the participant’s account balance. Check with the annuity company. There are number companies that have a variety of features which address these issues: some have death benefits; some are "cashable," having some sort of surrender benefit; some have a guaranteed payment over time.
  2. Check for annuity purchase rates. Though "fees" are the typical focus of fiduciaries, that’s not not the proper inquiry for these sorts of annuities-it really is all about seeing how much benefit can be purchased for what price. Check commissions.
  3. Make sure the annuity is designed for a retirement plan: make sure there are unisex mortality; that it can do the proper Schedule A reporting; that there can be appropriate valuation; and if there’s a death benefit, the incidental benefit rules are met. Depending on the type of contract and features, there may be a couple of more things to check out.
  4. Decide whether to hold the annuity in the plan and pay the benefit out from the plan; or issue the annuity from the plan as a plan distributed annuity. If distributing, make sure the plan document permits in-kind distributions.
  5. Review the range of variable and living benefits that may be available, where, inflexibility and inaccessibility are not a problem.
  6. If allowing participants a choice of annuities, if an advisor is used, and any of products are registered products, make sure the advisor follows FINRA’s suitability rules.

Of course, check out the insurance company (see Part 1).

Next up: Invisibilty: the sale/advising side of annuities

Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

 

 

 

The Swagger

I had the privilege to speak on a 403(b) panel at the recent DOL/ASPPA "DOL Speaks" seminar,   with Lisa Alexander and Susan Reese of the DOL.  Our own panel went very well, with Susan and Lisa both speaking directly to and recognizing the transition problems related to this new 403(b) world. As Lisa repeatedly pointed out, many of the rules causing the challenges have always been there, but not given much attention by 403(b) employers or their advisors. The audience showed some frustration, but that arises from there not being answers to a lot of the tough questions we now face.  But our take away is that the DOL is spending time and smart effort in recognizing the difficult issues now being raised, and is considering ways to approach them.  You will from time to time see in this blog me disagreeing with their chosen approach, but it will never be a criticism of the seriousness of their choices nor of the professional manner in which they are being handled.

This conference was my first serious view of the direction of the EBSA under Phylis Borzi, and it is already showing some swagger under her leadership. My first clue came from the EBSA’s staff’s position with regard to the material being presented. We are all very used to the typical government staff comment during most such seminars that any comments of staff in their presentations reflect their own personal opinions, not that of their employing agency.

Well, at this seminar, the DOL took accountability. None of their speakers issued this disclaimer. My own presentation material was reviewed with the view that in a seminar labeled "DOL Speaks", it couldn’t very well disclaim what its staff members were saying. So the staff statements took on an import we have little seen at other such conferences. This was a rare act of bureaucratic courage.

Phylis’s comments about the EBSA’s priorities sounded a more hardened approach to enforcing the public policy underlying ERISA.  It reminded me some of my favorite line from one of the all time great movies, "Mr. Smith Goes to Washington". A "little bit more of looking out for the other guy" is what I recall Jimmy Stewart saying.  Plan participants have always had this kind of advocate in the EBSA, but those efforts look to clearly become more focused.

Annuities to be addressed

At long last, both the DOL and the IRS will be taking a look at the technical rules related to the offering of annuities in 40(k) plans. The DOL announced that they will be soon be publishing an RFI on annuity issues, while the IRS  announced that they will be considering auto-annuitization. This will be both challenging and fun, particularly as it comes to making annuities sensibly transparent, able to be effectively compared, and in designing programs that make sense for those with modest accumulations. 

And for those of you still looking for Part 2 of my fiduciary analysis of annuities, its on the boards and will be out shortly.

 

Two recently published studies demonstrate the sort of shift in the "conventional wisdom" related to annuities for DC plans that needs to occur for those products to be successful in the marketplace.

One of the struggles the market continues to encounter is the limited  manner in which many policy wonks (with the notable exception of David John, Mark Iwry, Bill Gale and a few others) and advisors within the DC plan community continue to view annuities.  There is still a prevailing view of annuities as being simple "straight life" annuities, a view which ignores the recent development of innovative products in the individual, "non qualified" annuity marketplace.

The first study is a troubling example of this stodgy way of thinking. It is the recently issued GAO report, written for George Miller, Chair of the House of Representative’s Committee on Education and Labor, called "Alternative Approaches Could Address Risks Faced By Workers But Pose Trade-Offs." It is, by all accounts, a very thorough and well done analysis of what the authors view as the current alternatives to "decumulation" from DC plans. It  ignores, however, the an entire range of "living benefits" and other sorts of guarantees which have been successfully used in the "non-qualified" marketplace. It is these sorts of guarantees which can address many of the fears of plan fiduciaries and plan participants that the purchase of an annuity is merely a bad bet made against the insurance company (see an earlier post discussing these fears).      

I encourage you to look through the GAO report, and then compare it to the second study.  Kelly Pechter wrote a recent article in his Retirement Income Journal of a study published in the Journal of Financial Planning by Gaobo Pang and Mark Warshawsky entitled "Comparing Strategies for Retirement Wealth Management: Mutual Funds and Annuities."  These two economists analyzed 6 alternative models for  for guaranteeing income out of a qualified plans, focusing on 401(k) plan accounts and IRAs. 3 of their models addressed innovative marketplace methods: the use of one of the "living benefits"-Guaranteed Minimum Withdrawal Benefits (GMWB)- as well as variable annuitization and gradual annuitization. This study does not provide all the answers, as there continues to be a number of technical/legal issues which need to be settled to make these things really work well in qualified plans (see  another, earlier post discussing these issues, referencing the CCH and BNA papers). But it finally opens the door to the sorts of discussions we need to be having in order to make DC annuities work. 

Retirement plan vendors throughout the industry are engaging in efforts to prepare for the new disclosure requirements for the 2009 Form 5500 schedules, particularly the disclosures related to direct and indirect compensation under Schedule C and the substantial requirements for Schedule A.

I had the pleasure of a couple of informative conversations this week which were very enlightening. First, Tom Horton of Barrett and McNagney (and one of the very best retirement plan lawyers I know) and I were talking about some about the effects the new Schedule C will have on the plan administrator’s obligations (I know, I know, we need to get a life!). We spoke of how the Schedule C will be providing data for the fiduciaries to which they never had access in the past related to 12(b)-1 fees, sub-transfer fees and other sorts of revenue sharing.  What do they do with it? Well, it seems that that they would be ill advised to ignore it. Failing to undertake a review of the data once they receive it may well result in a fiduciary failure. But there is yet another twist. The plan administrators may well need to be on the lookout for the data. If they don’t receive it, they are under the obligation to report that failure. Failing to report that failure can trigger non-filing penalties for the Form 5500.

If that wasn’t depressing enough, Janice Wegesin, author of the Form 5500 Preparer’s Manual  and I had a conversation about how the Form 5500 Schedule A applies to individual ERISA 403(b) contracts. The data demands are really pretty incredible. The best example is the requirement under the Schedule to report consolidated information on transfers between the insurance company general account investments and variable investments under those individual contracts. I know of several employers with thousands of such contacts. I’m not sure I want to be anywhere near those 5500’s. But like the Schedule C, there is a reporting requirement under Schedule A which requires the plan administrator to report vendors who do not provide that data to the plan. So it means that plan sponsors will need to be looking for this ugly data.

Its going to be an interesting reporting season, I’m afraid.

 

 

 BNA reported on August 20th the concerns of the AICPA’s  403(b) Plan Audit Task Force about practitioners "misunderstanding" of the impact of the recently issued DOL FAB 2009-2, where the DOL took steps to alleviate some of the more draconian impacts of the new Form 5500 reporting rules for certain 403(b) plans.

Task force members are reported to say that the relief does not change their duties, as it does not change the DOL regualtions. With this statement, I must strongly but respectfully disagree with my CPA colleagues. For some plans, 2009-2 will make a significant difference in the work that needs to be done.

It is very true that 2009-2 is no panacea. The transition from treating 403(b)s as essentially individual pensions to treating them as fully employer sponsored plans is proving to be more difficult than even the most cynical of us could have imagined.  2009-2 does not change that. There are many unresolved administrative and fiduciary challenges facing 403(b) plan sponsors, and the task force’s concern that some employers may read 2009-2 as bringing more than transitional reporting relief is well founded.

I do empathize with the auditors, as they are the focus of much of the new 403(b) rules. They are learning a new "art", as the profession (with a few very notable exceptions) has so little experience in this field. The applicability of both GAAP and auditing standards will be difficult in an environment where the fiduciary does not control many of the assets or contracts, a circumstance which may even cause a need to review how those standards should work in this environment. It is not, after all, the same control environment as a 401(k) plan.

But 2009-2 does truly change what the auditors need to do for a number of plans, and employers need to be aware of this.

Employers need to spend time with their auditors and explore where the auditors should be spending their time, and where 2009-2 may (or may not) be of some use to the plan.  It means that (for some employers) auditors will not need to spend a lot of employer resources chasing down data which cannot be retrieved (for a large number of reasons, ranging from system limitations to privacy laws). Indeed , the FAB requires auditors to advise plan sponsors of any issue which may materially raise the auditing costs to the plan.  Employers should pay attention to this requirement closely, as active involvement in the 403(b) audit may result in significant cost savings.  Because the DOL has said it will accept a "qualified" opinion on a 403(b) plan if it is based on 2009-2, the limited auditing resources of some plan sponsors could be better spent establishing "good faith" rather than tilting at the data "windmill."

One also cannot overlook the 2009-2 value for many smaller employers of not counting many of those old contracts toward the 100 participant audit trigger.  

There are severe limitations on 2009-2, to be sure. But those dealing with auditors do need to understand that it will, in at least some instances, change the extent of the work auditors will need to do.

 

 

 

 

I sat sown this morning to follow up with Part 2 of my mini-series addressing the fiduciary risks in purchasing DC annuities (link here to Part 1), when a Plan Sponsor magazine article caught my attention. It spoke of a study which linked  the lack of pensions with the risk of poverty among women and minorities. The study, by the National Institute on Retirement Security, claims that it provides hard data on the unique impact of defined benefit type of income on older Americans’ economic well-being.

I do not know the Institute or the authors of the study, and the conclusions raise a while host of issues related to whether its the pensions or the type of employment related to the pensions. But the fundamental issue is one which served as a basis of my (now becoming) annual Mother’s Day blog, "ERISA and Mom," . If I recall, it was studies like these which were presented to Congressional hearings leading to the passage of Retirement Equity Act of 1984. It also means that the risks may not have changed all that much over the past 25 years.

If the study holds water, it really does help answer the question of "why annuitize from a defined contribution plan?"  If there is indeed a demonstrable impact of maintaining a DB type of  program instead of just a DC type of program, annuitizing from a DC plan may be attractive to employers.

DC annuitization does some things a DB program cannot: it permits an employee to elect what percentage of his or her retirement benefit can be used to provide lifetime guarantees while permitting the choice between a wide variety of carriers with a wide variety of terms.

It may provide further impetus for employers who really do want a DB program but do  not want to deal with the risk exposure, hassle and expense of maintaining one.

 The DOL’s release of FAB 2009-2 may well more significant than I took at first glance. Soon after blogging on the release of the FAB and how it sets us up to develop a more permanent solution, Ellie Lowder and my colleagues Evan and Monica let me know of a different view: they believe that the relief only make sense if it applies to all years-as the data collection requirements in future years for those old contracts will only get worse, not better. The NTSAA has taken this position in a notice to their members.

The FAB itself is silent on the specifics of its application to future years, and it is clear that the DOL was focusing on the immediate problems posed by the 2009 Form 5500. But I’m now convinced after to talking to a number of colleagues that there is little reason to believe that this same reasoning will not apply to future years.  Should this position hold sway, and I believe it will, this is a pretty incredible move on the part of the DOL . It  addresses the most troubling of the new generation of 403(b) Title 1 issues.

The DOL’s Lisa Alexander and I will be talking about those other pressing 403(b) Title 1 issues at ASPPA’s  "DOL Speaks" in Washington on September 14 and 15. Come join us!